Achieving a successful contractual joint ventureFebruary 20, 2018
This is the fourth issue of our Strictly Boardroom briefings that take you behind-the-scenes of common corporate and commercial transactions. Previous issues have looked at company sales, company acquisitions and private equity fundraising. In this issue, we look at some of the main things to consider when entering into a joint venture with another party – on a contractual basis as opposed to setting up a separate company or partnership vehicle. This type of transaction is commonly known as a contractual joint venture (or sometimes an unincorporated joint venture or a collaboration, co-operation or consortium).
Parties generally opt for a contractual joint venture when they want to leave their existing organisations intact and simply work together. It reduces the formality and administration of running a separate business vehicle and is generally a little easier to end. Importantly, in a properly constructed contractual joint venture, the tax status of the parties remains separate – so each party makes profits, suffers losses, pays tax and claims reliefs on their own account. Even though some external parties prefer the clarity of doing business with a joint venture company (and public bodies may find commercial ventures easier via a joint venture company), contractual joint ventures remain extremely common.
Typically, contractual joint ventures are used where two (or more) parties wish to collaborate in relation to a significant project. This might be a construction project, a joint tender, an R&D project, the exploitation of a new product or service or a collective marketing initiative. In fact, contractual joint ventures can accommodate most forms of collaborative business activity.
So, here are our TOP 10 TIPS for a successful contractual joint venture:
TIP 1 – Be clear on why you are each entering into it You and your joint venturer need to be crystal clear from the outset about the purpose of the joint venture and what your shared and individual vision, aims and objectives are for it. Everything you each do from then onwards should align with this.
TIP 2 – Protect your confidential information during the early discussions It’s easy to get carried away by the enthusiasm and excitement of a new project and drop your guard. During the pre-contract phase, make sure you have established the ground rules concerning confidentiality, exclusivity (if any), non-competition commitments, communication protocols and professional adviser conflicts. These issues might be captured in a memorandum of understanding, heads of terms or a simple mutual confidentiality agreement.
TIP 3 – Avoid an inadvertent partnership If you want to set up your joint venture as a partnership you can certainly do this, but the objective of a contractual joint venture is to avoid this. To reduce the risk of creating a partnership with your joint venturer, make sure that neither of you has the power to bind the other and that external parties dealing with the joint venture know with whom they are contracting. Ultimately, a court will decide if a partnership exists but a clear statement in the joint venture agreement that no partnership is being created is helpful evidence of the parties’ intention. Ensure that net profits (as opposed to gross income) accrue to each party separately (not jointly) and avoid joint and several liability obligations to third parties. Assets used in the joint venture should remain in the legal and beneficial ownership and operational control of the party bringing them to the joint venture. And try to avoid the term ‘partnership’ in external communications about the joint venture.
TIP 4 – Know what each party will be contributing Contractual joint venture parties usually carry out specific parts of the joint project using their own separate business resources, so it’s important to be clear about who is contributing what and what duties and responsibilities each party will have. For example, one party may need to licence its intellectual property to the joint venture whilst the other party may contribute technicians. The basis on which these contributions are to be made should be set out in the documentation to manage the parties’ expectations and to avoid disputes.
TIP 5 – Sort out the funding principles at the outset Let’s assume the joint project has several phases. Phase one might be putting together a joint bid for a contract. How will the bid be funded by the parties, win or lose? If the bid is won, phase two might be running the contract for months or even years. How will the parties fund this? Will they contribute equally, with or without any financial limit, or will some external funding be required? If so, who is going to arrange this and what security, if any, is to be given and by whom? Ironing out these things at the outset can avoid unexpected and painful cash calls.
TIP 6 – The devil is in the documentation Every joint venture is different and the documentation will need to be tailored to each one. For some joint ventures, the parties will want all the terms in a single document. For others, there may be a framework agreement governing the overall relationship between the parties, leaving the day-to-day operational aspects of each phase to be dealt with in supplemental agreements. Often it will depend on the subject matter of the joint venture and often industry conventions will dictate how things are done. Either way, there is much detail to be agreed upon such as how business plans and performance criteria will be developed and agreed, who will own any new intellectual property developed during the joint venture, how the parties will communicate and manage each other’s activities and how long the relationship is to last. More contentious matters can include restrictions on the parties’ freedom to assign their joint venture interests or sub-contract their joint venture obligations.
TIP 7 – Make sure the key assets needed are genuinely accessible A party may commit to providing an asset for use in a joint venture, only to find that a third-party consent is required. So, for example, a party might offer the use of factory facilities which requires landlord’s consent or might offer the use of customer data which requires extended data protection consents. In some sectors, joint ventures may require regulatory, competition or other approvals or clearances and so agreeing who is to be responsible for obtaining these, and what is to happen if they are not forthcoming, should be an early priority.
TIP 8 – Have an effective risk retention and risk transfer strategy Nobody goes into a joint venture expecting it to fail but project risks are unavoidable. In a well-managed joint venture, the parties will conduct a ‘risk audit’ to identify all the risks to which the joint venture and the joint venture parties are exposed. This information can then be used to compile a ‘risk register’. A risk that appears on the risk register can be managed in two ways. It can either be retained and managed by one or more of the joint venturers (known as ‘risk retention’) or it can be transferred to a third party, usually an insurance company (known as ‘risk transfer’). Developing a comprehensive risk retention and risk transfer strategy and delivering a plan to implement it is known as ‘risk management’. This is best achieved through a combination of careful analysis by the joint venturers, the use of experienced legal advice on insuring clauses, limitations and exclusions in the project documentation and specialist insurance broking advice on the placement of insurance cover.
TIP 9 – Agree how inter-party disputes will be resolved Reduce the impact of disputes by working out how disputes arising under the joint venture agreement are to be resolved and codifying this in the agreement. Some joint venturers even agree to park disputes until the joint venture project has been completed to avoid reputational damage.
TIP 10 – Parting is such sweet sorrow Shakespeare’s Juliet knew a thing or two about endings – needless to say, a little more preparation on her part would not have gone amiss. A joint venture agreement needs to cover termination issues head on. These include when and how the agreement can be terminated, the ownership and use of ‘joint assets’ created during the agreement period, what restrictions the parties may have in dealing with former customers of the joint venture, who will provide ongoing support to customers of the joint venture post termination and how outstanding costs and expenses are to be allocated.
By taking the time and the advice necessary to get the joint venture documentation right, you should end up with a very powerful tool with which to manage your joint venture relationship on a day to day basis, fulfil your leadership duties and responsibilities and safeguard your own organisation’s stakeholders.